How Does the U.S. Tax Foreign Companies?

How the U.S. Taxes Foreign Companies

Before you set your 2018 income, growth and profitability goals, it’s important to understand how the U.S. taxes foreign companies. There are some important, sweeping changes that the newly passed tax law has made to taxation of domestic and foreign corporations.

Current Taxation Structure

Under the past federal tax law, any foreign company that generates income in the U.S. must file a U.S. tax return on what is deemed “effectively connected income.” Many countries have tax treaties with the U.S. that govern the treatment of income earned in each respective country, and the terms of these treaties will override more general federal tax laws.

These treaties can offer some benefits to foreign corporation owners— including the ability to shift some taxable income to a country with a lower tax rate than the U.S. However, these treaties don’t exempt all income. Specifically, passive income (like dividends or stock appreciation) may be taxed in the U.S. at a different rate.

In addition, federal tax provisions aren’t binding on the states, so it’s possible that a foreign business could have a $0 federal tax liability but a much higher state one.

Changes under New Tax Law

According to attorney Doug Zanes, perhaps the biggest change made by the 2017 tax bill to how the U.S. taxes foreign companies was the across-the-board decrease in corporate tax rates from 35 percent to 21 percent.

However, CNN explains, before benefitting from that reduction, companies may have to deal with a one-time write-down of the value of existing tax credits—credits they’d saved from past losses. CNN reports that Barclays, Credit Suisse, UBS and Shell estimate that this could cost each company between $1 billion to $3 billion.

The new law establishes limits on foreign tax credits as well, and EY recommends that companies examine tax credit carryforwards in light of these new limitations.

This tax law also significantly expanded the number of business owners who can now use the cash, rather than accrual, method of accounting. While switching to the cash method may not be the best decision for every business, it can provide owners with some flexibility in how certain expenses are depreciated.

Of course, these are just a few of the monumental changes that will affect companies, so it will be incredibly important to do conduct business planning with tax accountants and attorneys in the coming weeks and months. To get started, contact Zanes Law.